The Martha Stewart Stock Scandal: Misinformation Persists

The Martha Stewart Stock Scandal: Misinformation Persists

Although it has been almost ten years since Martha Stewart made her fateful decision to sell her shares of ImClone Systems Incorporated, the misconception still persists among the public, and many journalists, that she went to prison because of insider trading violations. However, Martha Stewart was never convicted of insider trading. While she was alleged to have committed this offense, the judge dismissed the general charge of securities fraud. Understanding what her illegal actions were is a key to seeing the reoccurring business ethics lesson: an attempt to cover up a small transgression can lead to a series of larger lies and, ultimately, prison.

Martha's path to incarceration began when her stock broker informed her that, Dr. Sam Waksal, the C.E.O. of ImClone, was selling all of his shares in the company. Martha owned almost 4,000 shares of the company, which were trading around $58 each. Based on the broker's information, Martha instructed him to sell her ImClone shares. It is not clear whether Martha knew the reason that Waksal was selling his shares. He had discovered that the Food & Drug Administration was about to deny approval of ImClone's cancer fighting drug, Erbitux.

Clearly, Martha Stewart's decision to sell her ImClone shares was not well thought out. Compared to her net worth, the value that her ImClone investment represented was inconsequential. Hindsight would certainly confirm this. By selling her shares one trading day before the FDA announced that Erbitux was not receiving approval, she saved about $45,000.

Insider trading occurs when people trade on the basis of non-public information that would likely have an impact on the trading price of a company's stock. It typically occurs when directors or officers trade on such information, though it also applies to third parties that rely on the information. In Martha's case, there was no evidence that she knew of the FDA denial or that she had any direct contact with any representative of ImClone. While it is arguable that the information from her broker still constituted inside information, in and of itself, this evidence was insufficient to justify a conviction and probably would not have led to any charges.

Thus, if Martha simply admitted to authorities that she did sell her stock on the basis of the broker's information, it may have been the end of the matter. Instead, she conspired with her broker to cover up the trades. They concocted a story that she had an arrangement with the broker, called a stop-loss, to sell the ImClone stock if its price fell below $60 per share. Others were asked to participate in the charade and the lies continued to grow. However, further investigation unraveled this lie and criminal charges resulted. Martha was eventually convicted of conspiracy, obstruction of an investigation, and making false statements to federal investigators.

Just as the executives in companies such as Enron and WorldCom initially made small adjustments to accounting assumptions in order to meet earnings expectations, Martha Stewart lied in order to conceal a relatively small transgression. In all of these situations, initial lies blossomed into larger ones, with the end result of imprisonment. The reoccurring lesson is to avoid taking the first step of concealing the truth since it too often leads to much more serious, life-changing implications.

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